Slumping stock markets have opponents of personal accounts claiming vindication. The situation shows, they argue, that only a traditional government-mn, defined-benefit Social Security program can provide adequate retirement security. As then-Senate Majority Leader Tom Daschle put it on July 12, 2002, "After what's happened in the stock market the last few weeks, we think it's a terrible idea. ... Imagine if you were retiring this week, with most major stock indexes hitting five-year lows." Indeed, many Americans are sure to be concerned after hearing such comments.

Yet, in judging the risks of long-term market investment based on just a few months or years of returns, these opponents of personal accounts are victims of the so-called "law of small numbers"--the propensity to believe that a small sample is representative of the larger universe of outcomes. Like those who took a few years of double-digit stock returns in the 1990s and predicted that they signified a future of limitless investment riches, personal account opponents have failed to take an in-depth look at the historical facts regarding stock and bond returns over the long term.

These facts show that, even now, personal accounts would increase benefits and help strengthen Social Security for the future. However bad the market's recent performance, a worker retiring today would have begun investing in the late 1950s. The stock market has never lost money over any 20-year period. Even without diversification, a worker retiring today would have 40 years of investment behind him or her to make up for recent losses. A worker just entering the market would have 40 years to regain lost ground. There is simply no way recent events can credibly justify a disastrous scenario for personal accounts. Even a worker retiring in the Great Depression would have received a four percent annual return after inflation, and one retiring today would do substantially better.

Personal accounts give workers the opportunity to diversify their investments across hundreds or even thousands of stocks and bonds, reducing the risk that declines in a single company or asset class would severely impact retirement income. Moreover, long-time horizons provide "time diversification" that smoothes out the short-term volatility of investments in the stock market.

Historically, in almost all cases, workers with diversified market investments would have received substantially higher benefits if allowed to invest part or all of their payroll taxes in personal retirement accounts. Looking forward to Social Security reform proposals already on the table, practically all workers could expect to increase their total retirement incomes by opting to participate in personal accounts, even if they had to give up part of their traditional benefits to do so.

Asset diversification: mixing stocks and bonds. Stocks are risky investments over the short run, varying greatly from year to year. Bonds and other fixed-income investments, while producing lower returns over the long term, provide the year-to-year stability that many investors demand.

For this reason, most financial advisors recommend that investors move from a predominantly stock-based portfolio when they are young to fixed-income investments such as bonds as they near retirement. Younger workers have more time to make up for market losses, as well as more future labor income with which to supplement their savings. A common rule of thumb is that the percentage of stocks in a worker's portfolio should equal "100 minus your age," so that a 20-year-old would begin his or her working life with 80% of savings going into stocks and retire at 65 with just 35% in equities.

Statistics from 401(k) plans show that most workers stick reasonably close to these guidelines. The average worker aged 60-65 keeps about 40% of 401(k) assets invested in stocks and 60% put in fixed-income assets such as bonds. …

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